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Monday 26 February 2018


Guest Post by PlanetNL

PlanetNL7 – Can Muskrat Float After a Bailout
In prior PlanetNL postings, Muskrat economics have been shown to be unaffordable to consumers and a major threat to the solvency and survival of the Government of the Province.  Write-offs are a certainty and there may be many who think the project might look good after that.

Equity write-downs and restructuring of unmanageable debt are well known practices in the corporate world.  Does Muskrat have the potential to avail of such opportunities and would operations then make economic sense? 

Analysis, Background and Assumptions
The massive spreadsheet behind PlanetNL3 entitled "Muskrat Falls Subsidies Will Cause Gov't Debt Spiral" is employed again to create a series of charts to tell the story.  The fundamentals are the same: two Nalcor ATIPPA information releases provide cost and revenue breakdowns of the massive Power Purchase Agreement and the Nalcor forecast of Dividend and Export Revenue.

Unlike Nalcor, this analysis considers consumers ability to pay and how much power they are likely to use after massive price increases.  Nalcor predicts that electricity sales will not substantially decrease when price potentially more than doubles, but this is irrational propaganda.  Many Newfoundlanders will substitute away from electric resistance heating to something else or simply dial back their usage.  Virtually everyone will find other ways to reduce consumption of non-heating electricity as well.  This analysis assumes a near-30% drop in energy sales from 7000 GWh down to 5000 GWh.

Dissection of the Power Purchase Agreement
Shown below is the 50-year Power Purchase Agreement needed to pay for Muskrat broken down into its primary cost categories [source: Nalcor data].  The biggest slice is the heavily backloaded Return on Equity.  Depreciation is a constant 2% of capital cost per year.  

Interest costs are, as typical, high early and decreasing over time.  These 3 elements are the principal areas targeted in a “write-off” of equity and debt.

As step one, equity and depreciation are removed.  Keep in mind this means that the Province’s $4.0B equity contribution is a complete loss and Emera’s $800M in equity must go as well.

When an asset is written down in value, future depreciation must also be reduced.  As the conclusions will show, Muskrat will never plausibly make any money therefore the asset is worthless and there is nothing to depreciate.

The chart below still contains more PPA costs than available revenue, so the next required step is for Ottawa to assume full responsibility for the $5.0B Federal Loan Guarantee signed off by former Prime Minister Harper in 2012 and for the $2.9B approved by current Prime Minister Trudeau in 2016.  This removes interest costs.

At this point, costs are stripped down about as bare as may be reasonably possible.  The relatively small Water Power Rental costs could be construed as being ROE-like Provincial revenue, however, leaving it in does not change the analysis much and it may be argued this amount is a small contingency for unforeseen costs (for example, a source of revenue to provide electricity bill support to many low income people who are going to have serious problems with the steep rate hikes).

Muskrat Subsidies Will Cause A Gov't Debt Spiral

Available Revenue – Increased Ratepayer Billings and Exports
As presented in PlanetNL3, two key simple broad-stroke assumptions for estimating ratepayer contributions are (1) energy sales held flat at 5000 GWh and (2) energy price set by the Premier’s publicly stated goal in 2017 for a domestic price of 17 c/KWh in 2021. The energy price is escalated by 2% inflation annually thereafter.  After deduction of non-Muskrat NL Hydro and Newfoundland Power costs, surplus ratepayer cash flow available to pay the Muskrat PPA is calculated and shown as the main component of the chart below. 
Energy export revenues are shown exactly as specified in Nalcor projections.  While more energy is sure to be available for export, Nalcor’s export profit margins are prone to severely decrease – the two issues likely negate each other and therefore no changes to export revenue are made.

Net Earnings After Write-Offs
Finally, the net earnings are calculated by taking the Muskrat revenue and subtracting the revised PPA costs (two charts above).  The results are a mixed bag.

Some positive net earnings potential in the first 20 years indicates that the energy pricing in the model is a little too high.  This would be corrected by holding the price flat at 17 c/KWh until 2029 and only adding some inflation after that.  This spells some minor relief for consumers who will still be seriously hurting from the steep rate hike from 9.7 c/KWh in mid-2016 up to 17 c/KWh in 2021.

The growing losses in the final 20 years will demand price increases greater than the assumed 2% per year during that period to achieve breakeven.

Is This Good?
Breakeven is a generous term because heavy baggage has simply been shifted elsewhere.  The Province has to deal with its $4.0B in unrecoverable equity.  Emera must lose its $800M equity.  Ottawa has to take on $7.9B.  None of these things are good and indeed they leave considerable room for very ill after-effects.

Breakeven also depends on Nalcor’s Operation and Maintenance cost assumptions proving correct and that the quality of the assets is everything they hope it is.  If costs rise, NL consumers are asked to pay more.

The model also doesn’t consider other risks that Nalcor disavows including the strength and longevity of the North Spur, the long transmission lines designed to somewhat modest storm criteria, and a dubious Water Management Agreement contested by Hydro Quebec and still before the courts.

Also consider, this massive Newfoundland energy project isn’t turning out to be for Newfoundland energy needs after all.  Once decreased energy demand becomes a reality in this Province, Muskrat Falls may be completely unnecessary to the energy requirements of this province.  The project will prove to be all about meeting Nova Scotia’s energy needs.  What started out as an agreement where Nova Scotia would receive 20% energy for a 20% cost-share is morphing its way toward 100% energy to Nova Scotia for their 20% cost (or possibly less).

As presently constructed, the Muskrat contracts with Emera have Newfoundlanders paying nearly the entire shot for benefits that accrue exclusively to Nova Scotians.  The economics of export beyond Nova Scotia has become infeasible while Nova Scotia has the potential need for the entire output of Muskrat all by itself for most of the year to offset their dirty coal plant energy production.  Only in the summer season would there be surplus energy to possibly export to the USA and a large portion of that revenue would be lost to transmission fees.

No, none of this is good unless you live somewhere between Yarmouth and Glace Bay.  Having another province finance your future electrical energy security must be a nice feeling.  Or maybe it just feels weird.  Not only that, Newfoundland ratepayers are on the hook for 50 years of operations costs to deliver that power to you – how sweet is that.  Emera and the Nova Scotia Utility and Review Board have wrangled for Nova Scotians the one-sided deal of a lifetime but the deal may prove too one-sided for their own good if they starve the Golden Goose to death.
If Ottawa and Emera Refuse Write-Offs
Taking the Net Earnings chart above and adding back interest costs and Emera’s Return on Equity creates a serious set of losses.  Two things stop this chart from looking far worse.  First is the absence in any way of the NL Government’s $4.0B equity – this is a write-off Nalcor clearly can’t pay back.  Second is that the Province is on the hook to supply Nalcor the major funds required to retire the $7.9B in project bonds – the company won’t get the money from ratepayers therefore it must beg to Government to assume the debt.

Growing Annual Deficits
The Province will be saddled with huge Muskrat costs if Ottawa and Emera don’t participate in the write-offs.  Firstly, the Province must grapple with its $4.0B in lost equity: this failed high-risk gamble was made with borrowed money that will be festering in the Public Accounts and growing heavy interest every year.

Add to this the annual subsidy to Nalcor to cover Muskrat’s losses on operations.  Already deeply in debt, the Province must borrow that money.  Then the Government must start borrowing more money to pay interest cost on the bonds obtained to provide those subsidies. 

As debt is set to be retired inside Nalcor, massive new bonds must be taken out by Government until all $7.9B of debt is eventually transferred to the Province.  For the model, the exact schedule of bond maturity dates is replaced by a simple linear 50yr x $158M/yr rate of debt transfer – only the interest costs are shown below.

The chart below roughly predicts the growth to Government’s annual deficit due solely to Muskrat.  The burden begins at $500M annually.  We may as well forget that it rises exponentially.  The Province is no position to deal with this addition to the deficit and will be in dire straits early in the first decade.

If Ottawa and Emera participate in the full write-down, the picture is still a very problematic one for the Provincial coffers as the interest costs on the lost $4.0B equity will still be due.  Given the present state of finances, even this component alone is not realistically ever going to be paid off by the Province.

Ottawa May be Liable for $12.7B
It is essential to the survival of the Province that a financial restructuring of the Muskrat project take place as early as possible.  The Federal Loan Guarantees must result in the debt being fully taken on by Ottawa.  Emera must bow out of its equity stake.  The Province must write-off it’s project equity.  This is all just the start. 

Barring miraculous unforeseen windfalls, the Province is still mired in a debt crisis from which escape on its own appears impossible.  It is foreseeable that Ottawa will be compelled to bail out the $4.0B in debt attributable to Muskrat.

In negotiating with Emera and Nova Scotia, it is probable that Ottawa will, one way or another, fully relieve Emera for its equity losses.

This adds up to Ottawa becoming fully responsible for the entire capital cost of Muskrat simply because there is no practical alternative.  To defer action and force Newfoundland into deeper losses will make the inevitable Provincial bailout more expensive.

Ottawa and Nova Scotia Must be Held Accountable
For this province, Muskrat appears to be an entirely worthless asset.  Only to Nova Scotia and Emera, who have already completed the Maritime Link and are still dependent on coal for about half their energy, does Muskrat offer any value proposition.

If Muskrat operations are to carry forward, the existing contracts between Emera and Nalcor must be completely revised to reflect the new reality.  Forcing Newfoundland ratepayers to bear the full cost of operations to subsidize Nova Scotians is a nightmare scenario that will breed the worst contempt imaginable.

Muskrat is a complete and total financial wreck and only Ottawa has the capacity to clean it up.  Given their gatekeeper role as project enabler and strategic financier twice over, the result would appear deserving.  They could never deny that they either knew the risks and they should have fully understood that a day of reckoning could likely come straight back to their door.

The question of whether Muskrat Falls operates at all must largely depend on a major renegotiation with Emera and Nova Scotia to pay their fair share of operating costs and liabilities in proportion to the energy they intend to take.  If Nova Scotia and Emera are intent on saying a deal’s a deal and inflicting misery upon Newfoundland, this Province should simply abandon Muskrat entirely and pull the plug.  There may be nothing left to lose at that point.

The tragedy of Muskrat was a purely political act of creation.  It must be political action that corrects it.